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On June 1, Bill Simpson wrote an analysis of Einstein Noah Restaurant Group (NASDAQ:BAGL). On June 13, the company sold 5 million shares priced at $18 per share. The net proceeds of the offering, after deducting underwriting discounts and commissions, totaled approximately $83,700,000. The stock closed on June 15 at $17.00.

The text of Mr. Simpson's original writeup follows:

• • •

Einstein Noah Restaurant Group plans to offer 5.8 million shares (assuming over-allotments) at a range of $19-$21. Morgan Stanley and Cowen are lead managing the deal, Piper Jaffray co-managing. Post-ipo BAGL will have 16.4 million shares outstanding for a market cap of $328 million on a pricing of $20. IPO proceeds will be used to repay debt.

Greenlight Capital (affiliated with recent ipo (NASDAQ:GLRE)) will own 60% of BAGL post-ipo. Greenlight assumed 97% ownership in BAGL following BAGL's reorganization from bankruptcy in 2003. Greenlight was a corporate bond holder in BAGL prior to the bankruptcy and those debt notes were converted to a nearly full equity stake following reorganization. Greenlight is not selling any shares on ipo, although a chunk of ipo proceeds will be used to close out a debt note held by Greenlight.

BAGL's shares currently trade (pre-ipo) on the 'pink-sheets' under the symbol NWRG. Looking through NWRG's most recent earnings release, it appears this is a very 'clean' move from the pink sheets to the nasdaq on ipo. Company structure-wise will act as a secondary offering of 5.8 million shares, which will be used to clean the balance sheet up by paying down debt. Debt levels will go from $227 million pre-ipo to $138 million post-ipo, assuming a pricing of $20. NWRG's stock price has ranged from $17-$22 over the 30 days pre-ipo, with very few shares generally traded.

From the prospectus:

We are the largest owner/operator, franchisor and licensor of bagel specialty restaurants in the United States. We have approximately 600 restaurants in 36 states and the District of Columbia under the Einstein Bros. Bagels, Noah’s New York Bagels and Manhattan Bagel brands.

einstein
The Einstein brand is located in 33 states, Noah's in 3 states and Manhattan concentrated in the northeast US. As with most bagel spots, focus is on morning and into early afternoon. Offerings include fresh bagels and other bakery items baked on-site, made-to-order breakfast and lunch sandwiches on a variety of bagels and breads, gourmet soups and salads, decadent desserts, premium coffees and an assortment of snacks.

Fast casual morning niche - Highly competitive segment in which BAGL operates. BAGL's largest component Einstein Bagels was created in 1995 by Boston Chicken. It appears that much like Boston Chicken, Einstein expanded too quickly, laying on debt to open new locations. This actually occurred pretty much across the board in the bagel segment as the bagel chains race to open new stores to grab the 'bagel' segment market share in attempts to be the 'bagel' Starbucks (NASDAQ:SBUX).

Pretty much all of them ran into financial difficulty as debt servicing overcame sluggish revenues. Consolidation ensued, the debt holders took over the various companies and a few years later we get the BAGL ipo. Even with consolidation in the sector, competition is fierce. BAGL competes directly with other bagel chains such as Brueggers, as well as coffee chains such as Starbucks, Dunkin' Donuts and Caribou (NASDAQ:CBOU) and other 'fast casual' morning stops such as Panera (NASDAQ:PNRA).

In addition many fast food restaurants such as McDonalds (NYSE:MCD) are focusing more on premium coffee and offerings that are directed at taking market share from the coffee chains and fast casual breakfast spots such as BAGL. It is a tough niche. The history of the 'bagel wars' from the late 90's is a perfect example of why debt levels are always extremely important to keep an eye on. When operations lay on heftier and heftier debt to expand either through new locations or acquisitions, the bar to insolvency gets lower and lower. Those who are interested in a primer on the importance of debt should research the bagel 'boom' and the theater chain expansions of the late 90's.

60% of BAGL's revenues are derived during the breakfast portion of the day. BAGL post-ipo will be the largest bagel operator in the US. 10 consecutive quarters of positive same store sales. This should have an asterisk though, as BAGL had negative same store sales for 2-3 years in a row prior to this pick-up, so the starting point here was low.

New stores
- For the past 5 years BAGL has focused on getting its financial house in order. This has included closing under-performing stores, reworking its entire in-store concept and managing the business (and each store) more efficiently. The result has been that BAGL has seen the number of stores decrease annually each of the past 5 years. As of 4/4/07, BAGL had 597 total locations, 410 of which were company owned, 100 licensed and 87 franchised.
bagels
In 2007, however, BAGL plans to begin a moderate expansion of company owned stores by opening 10-15 new stores under the Einstein and Noah brands. BAGL also plans on much more aggressive licensing and growth. Licensed locations are located in airports, colleges and universities, hospitals, military bases and on turnpikes. BAGL opened 29 new licensed locations in 2006 and plans to open 30-40 new licensed locations in 2007. During BAGL's reorganization and aftermath, the franchising segment suffered greatly. BAGL has lost franchises annually each year this decade. It plans on growing this part of the business, however it appears much of the non-company owned growth is being directed towards the licensing concept.

Company owned restaurants account for 90%-95% of overall revenues.

Property - BAGL does not own any properties, it leases all restaurant space at company owned locations.

Financials

BAGL will have fairy significant debt post-ipo of $138 million.

Even with 10 straight quarters of same store sales growth, revenues have been sluggish this entire decade. As BAGL has operated more efficiently and grown same store sales the past 2 1/2 years, the impact in overall revenues has been nil due to store closings and loss of franchisees. Overall, looking at BAGL's revenues the past five years is akin to looking at a flat line with revenues 'stuck' from 2002-2006 at $374 million - $399 million.

2006 - $390 million in revenues, 20% gross margin. Indicative of improving store performance (and closing poorly performing locations), gross margins were highest in 4 years. Operating margins were 11%. Debt servicing costs (factoring in reduced debt servicing based on debt paid on ipo) ate up 40% of operating profits. Depreciation & amortization charges took away a bit more as well. Note that BAGL has approximately $150 million in tax loss carry-forwards from pre/post bankruptcy days. Even though it's capped on how much it can utilize in a given year, BAGL won't be paying taxes on any earnings for the foreseeable future. So we'll give a 'no tax' number here for net and then a 'tax plugged in' number so that BAGL can be compared apples to apples with the sector. 'No tax' net margins for 2006 were 3%, fully taxed would have been 2%. Earnings per share not taxed were $0.80, plugging in taxes they would have been $0.50.

2007 - Much as rest of decade previous, first quarter 2007 revenues were flat compared to first quarter 2006. Same store sales increased 1%. BAGL had 21 fewer restaurants in the first quarter of 2007 as compared to first quarter 2006. It would appear BAGL is about completed shuttering non-performing stores (only 20 more anticipated closing next three years as leases expire) and is about to embark on company owned store expansion. The plan is for controlled growth, so I would expect the number of overall company stores to grow all that much in 2007 overall. I would expect overall revenues to be in the $390-$400 million ballpark for 2007. Gross and operating margins should be similar to 2006. BAGL will benefit in 2007 from decreased amortization & depreciation costs which will assist to boost the net margins and bottom line. Net margins ('no tax') should improve to 3 1/2%, taxed to 2 1/2%. Official untaxed earnings should be in the $0.85-$0.90 range. Plugging in taxes, earnings would be $0.55-$0.60.

Conclusion
- Coming out of bankruptcy reorganization, management the past 3 years has done a nice job improving margins and same store sales comparables. Keep in mind much of this same store sales growth is attributable to sluggish performance in 2003/2004 as well as management simply closing non-performing stores. BAGL has extensive tax carry-forwards, meaning the bottom line here is greatly benefiting from not being taxed. Plugging in taxes, BAGL looks awfully pricey in range, especially keeping in mind past bankruptcy (for Einstein and Noah) and the not insignificant debt being carried on the books. Revenues have been stagnant, competition is fierce. BAGL to me looks to be a turn-around story at least fully valued in range.

Source: IPO Analysis: Einstein Noah Restaurant Plans For Controlled Growth Amidst Fierce Competition